Brooke’s Note: To grasp the intricacies of DOL’s 401(k) laws you need to be an ERISA attorney. But you only need to be a fourth grader of average intelligence to get why ABB got slammed with a massive judgment here and why Fidelity was basically found blameless. ABB made a plan for its regulator and apparently failed to follow it. It’s Planning and Compliance 101 that every RIA knows well and an accident waiting to happen that virtually any RIA could have warded off. Fidelity charged what were apparently high fees. But not with any grand deception or diversion from a plan. In America, a buyer still needs to be sufficiently beware to shop around a bit and a merchant can ask for a high price at the peril of savvy shoppers walking away.

In what many experts view as a landmark case focusing on the increasingly contentious topic of 401(k) fees, Fidelity Investments was cleared by a U.S. Court of Appeals 8th Circuit Court judge in relation to breaching its duty on “float” rates it charged on plan assets.

It is unclear how big the ABB’s 401(k) plan is currently, but court documents show that in 2000, the plan had more than $1.4 billion of assets and more than 14,000 participants. RIABiz was not able to reach ABB for comment by deadline.

In March 2012, the U.S. Court for the Western District of Missouri found multiple fiduciary breaches — mostly against ABB —and awarded the plan participants a total of $36.9 million. Those awards included $1.7 million that Fidelity was ordered to pay for breaching its duty on “float” rates it charged on plan assets it invested, and $21.8 million for share-class violations that ABB had to pay, as well as the $13.4 million for not properly monitoring recordkeeping fees. See: Why gathering big-time 401(k) assets — and charging regular fees — is well within reach for most experienced RIAs.

In Wednesday’s decision, the Court of Appeals upheld the earlier decision against ABB for not fulfilling its fiduciary duty to monitor recordkeeping fees properly, but reversed the District Court’s decision against Fidelity. In the third issue involving ABB’s share class violations (i.e. using pricier ones when cheaper ones were available), the court vacated the earlier court’s decision, which means the parties have to start from scratch on this point of dispute. See: An X-ray of one affluent, educated and sophisticated investor’s portfolio shows how it was chewed up by fees.

... and on attorney fees

As part of the Court of Appeals’ decision, Fidelity also won’t have to pay attorney fees. The earlier district court had ordered that ABB and Fidelity pay attorney fees of $12.9 million and $489,984 in costs. The Appeals Court vacated the attorney fees, which means it wants the district court to re-calculate fees and points out that Fidelity would no longer have to pay fees.

The Appeals Court also questions whether an hourly rate of $514.60 for attorneys is fair — especially if some of those hours were clerical or paralegal work.

“We leave for the district court to determine the amount by which the attorney fee award against the ABB fiduciaries should be reduced after resolving the remaining issues on remand. In recalculating any award, the district court should be careful to apply the generous attorney rate it has allowed in this case only to work that requires an attorney—not administrative, clerical, or paralegal work,” the decision read.

Bad optics

Despite the fact that the legal battle with ABB and Tussey will continue, Fidelity is pleased with the outcome, says spokesman Vincent G. Loporchio.

But Fidelity officials may not be in celebratory mode, according to Tom Clark, director of fiduciary oversight of Fiduciary Risk Assessment LLC and PlanTools LLC, and an ERISA attorney, who calls the ABB adjudication “the biggest case in this area in decades.”

“The claim is against ABB because they’re a fiduciary,” he says. “It still doesn’t look good that Fidelity’s fees were excessive and violated ERISA. But they don’t have to pay anything back. There’s no liability for Fidelity, but it just doesn’t look good for them,”

Long-haul good news

Fred Reish: It affirms the DOL position that plan sponsors and fiduciaries must prudently monitor the money paid to providers.

This case validates the DOL’s message that employers need to look more carefully at fees, says Fred Reish, an attorney with Drinker Biddle & Reath LLP.

“It affirms the DOL position that plan sponsors and fiduciaries must prudently monitor the money paid to providers. Over the long haul, that should reduce expenses to plans especially for those plans that are paying too much,” he says.

No all-clear signal

Even though Fidelity is off the hook in this case for fees, Reish questions whether recordkeepers could get fined for excessive fees in the future.

But in this ABB case, the court didn’t question Fidelity for its recordkeeping fees. Instead, the court determined that ABB failed to complete its due diligence for the recordkeeping fees paid to Fidelity.

In addition, ABB didn’t benchmark its recordkeeping fees. For example, ABB did not calculate the amount the plan was paying Fidelity for recordkeeping in its revenue sharing and ABB didn’t do any comparison shopping to see if the pricing was competitive, Clark says.

When Fidelity became the recordkeeper for ABB in 1995, the employer paid a flat fee for each plan participant. But in 2000 things changed and Fidelity began getting paid by revenue sharing, court documents state.

By 2001, compensation for the non-union plan came solely from revenue sharing, but ABB paid Fidelity $8 per participant and some additional revenue sharing for the union plan, court documents show.

“You can’t just pay providers with revenue sharing,” Clark says. “You have to calculate the numbers and only once you know what revenue is being generated for the services then you look at what would be a reasonable fee. If you’re not doing that, then you’re violating your duties. The judge isn’t saying that revenue sharing is inherently bad, they’re just saying that you have to be absolutely positive you know what’s being generated in revenue. You can’t turn a blind eye.”

Another takeaway, Roberts says, is that advisors are crucial even to big employers because the employers still aren’t savvy about 401(k) plans and rules.

“Even a company as big as ABB isn’t in business to sponsor a plan. They’re running their business. That’s the thing that keeps ringing in my ears is you have a sophisticated plan sponsor with a consultant and they had put them on notice and it still wasn’t resolved.”

Of plans and floats

Even though Fidelity won in regard to the “float” issue, it’s possible that it, too, could come up again in other cases, Reish says.

The earlier court decision found that Fidelity had breached its duty with the rate it charged on its “float” on plan assets it invested overnight. That court took issue with how the float interest was allocated and the issue became whether or not these fees were legal.

But the Appeals Court said Wednesday said that plan participants agree with Fidelity that the “funder of the check owns thefunds in the checking account until the check is presented, and thus is entitled to any interest earned on that float.”

The participants, however, contested the ownership of the funds at issue and argue that the owner is the plan making the float income a plan asset.

The Court of Appeals countered by saying that the participants did not cite any evidence establishing the “Plan” as funder of the check or owner of the funds.

“Absent proof of any ownership rights to the funds in the redemption account, the Plan had no right to float income from that account,” the Appeals Court ruled. “Because the participants have failed to show the float was a Plan asset under the circumstances of this case, the district court erred in finding Fidelity breached its fiduciary duty of loyalty by paying the expenses on the float accounts and distributing the remaining float to the investment options. See: The trusteed IRA: One tested method to maintain assets under management through the generations.

Share classes hang fire

One issue this latest ruling leaves up in the air is that of share classes. The Appeals Court judge vacated the earlier court’s decision about share classes, which Clark describes as a “do-over.”

This is a procedural victory for Fidelity, Clark says. The court wants this entire issue to be re-addressed,” Cark says.

At issue was the employer switching to a Fidelity fund that was comparable but had higher fees — creating at least the appearance of impropriety.

It’s a bitter win, Roberts says. “Yes, Fidelity can rest more comfortably but I don’t know if anyone wins in litigation. I don’t know if getting out on an appeal is really a win. I think a win would have been communicating and processing the information so they never would have been hauled into court in the first place.”

Stephen Winks said:

March 20, 2014 — 7:49 PM UTC

Institutionalized inefficiencies of a brokerage format will increasingly be successfully challenged in court which establishes the value of an advisor acting in a fiduciary capacity in the consumer’s best interest.

The ABB/Fidelity suit is just the tip of the litigation iceberg in which the brokerage industry will be forced to reconcile its suitability standard in the broker/dealer’s best interest and a fiduciary standard in the consumer’s best interest.

The bitter pill to be swallowed is that of the brokerage industry which has thwarted modernity and innovation in portfolio construction required by statute to serve the best interest of the investing public.

SCW

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